Top 3 reasons NOT to apply for a store credit card

If you've gone shopping at a department store lately, I’m sure you have been asked to open a store credit card. For doing this, you could save 10-, 15- or even 20 percent on your purchase that day.

Here are 3 reasons this is a very bad decision:

1. When you apply for a credit card, retailers pull up your credit report and scores. Multiple inquiries in a short period of time can reduce your credit score, especially if you don't have many credit accounts. Inquires account for 10% of your total FICO score. This type of inquiry stays on your report for 2 years and will affect your score for one year from the date it took place.

2. Retail credit cards come with a low limit in most cases compared to a general credit card. This is highly important because the second largest factor in your FICO score is the amount of credit card balances or credit card debt compared to the limits. For example, take a $250 balance on a store credit with a $500 limit; you'd have a 50 percent credit-utilization ratio. But on a $5,000 credit limit on a general credit card, the ratio is just 5 percent. The higher the ratio, the worse your credit scores!

3. Store credit cards usually also have very high interest rates.

With all that combined, stay away from the ever so tempting offer next time you are checking out to open a new card for the 15 or 20 percent discount. Don't use a new credit card as a discount coupon.

Did you hear about this?

Have you heard about the newest gadget you can buy for your car? You hook it up to your car and then as you drive it will give you a very rough estimate of how fast you are going. Plus it will give you a vague estimate of what the speed limit might be in the area you are traveling! This service has a monthly subscription fee of only $14.95 per month! The service I just described doesn’t exist and I made up the scenario just to prove a point. We as consumers can easily see the flaws in a product like this one, but when it comes to our credit we fall for things like this all of the time!

Let me explain. There are all kinds of “credit scores” on the market, but the credit score model used by the over whelming majority of lenders is the FICO credit score. Other scoring models will evaluate the information on your credit report and give you some kind of scoring range to show you where your score falls. Referencing back to the example above, Police Officers gauge our speed on miles per hour, not on some “other” calculation; therefore we are concerned with what they use to determine our speed. Similarly we need to concern ourselves with the model that lenders are using when it comes to our credit score. Here is a quick tip for you: if you are buying a credit score online, or getting a score from any source and it doesn’t say “FICO score” on it, chances are it is not a score that any lender would ever use to determine your credit worthiness!

Next, if you are concerned with your FICO score (which you should be unless you can pay cash for everything you will ever need in your lifetime) then you need to make sure you are getting advice on things you can do to improve your FICO score, not things you could or should do to improve some other credit score that has no merit. So many of these monthly monitoring services, credit score simulators and other services give you advice on ways you can improve your “credit score” not actual advice on how to improve your FICO credit score. If I can get a ticket for speeding I would much rather be able to look at the speed limit sign that tells me the actual speed limit that I am being judged on rather than receiving a ticket based on someone else’s guess of what the speed limit is.

Lastly, why would you ever pay a monthly fee to look at something you can view for free and, with a little research, get free advice on how to improve (I’m talking about your FICO score), which as you now know is really the only score that most lenders currently care about.

Most of the companies that have developed these other products (monthly monitoring services, credit score simulators, etc.) suck us in with catchy advertisements or by using reputable people in industries that we would assume are giving us correct information when promoting themselves and their services. In reality they are not much more than services that prey on our lack of knowledge as consumers and add even more confusion to the topic just to rope us in to a monthly subscription fee. My advice for most people is stay away from these kinds of services. They will just cost you money and confuse you even more.

More Foolish Advice!

A few weeks ago I was doing a public speaking event and one of the questions I received was “what is the best way for someone with no credit to build a credit score?” Before I answered the question the person got even more specific and told me that a bank had told him the best thing he could do was to deposit $1,000 (with this institution) then to take out a $1,000 installment loan against that deposit.

I am sure the bank had lots of “great” reasons as to why this was helpful advice, but telling someone this is the best and fastest way to build a credit score is where I take issue. Let’s address the issue of time first.

In order to generate a FICO score two things have to happen;

1. You have to have an account that has been open for at least 6 months (collection accounts do not count)

2. You have to have an account that has been updated to the credit bureaus at least once in the last 6 months. One account can work to qualify for both of these rules.

In looking at the criteria listed above you will not see that it mentions the “type” of account as a factor, since it doesn’t then we know the “type” of account is not a factor in how long it will take to generate a score! So in answering the time question of the equation the answer is 6 months if you currently have no credit now. Regardless of the “type” of account!

Let’s look at the other issue now; the goal is not to just have a score, but to have the best score we can.

If you understand how the FICO score works you know that revolving accounts (credit cards) hold a much higher value than installment loans. Knowing that is why I disagree completely with the advice from this bank. In this scenario it will be a lot better to get a credit card and use it properly, than it would be to get an installment loan. For someone with no credit at all the biggest challenge will be what type of card to apply for to have the best chance to get approved. For this situation we want to get a secured credit card. In case you are not familiar with this term, very simply it is a credit card where the limit is secured by a deposit. Most banks have a minimum amount of $250, so you give the bank $250 that they hold as a deposit, you then get a credit card with a limit of $250. This is what makes the account secured. Since it is secured it is a lot less risky for the bank which makes it a great option for people with no credit or damaged credit.

Comparing these two ideas, both will take 6 months to generate a score, the revolving approach will yield you a higher score when you generate a score than the installment option (if you use it correctly) and the last factor, with the banks installment idea it will tie up $1,000 of your money vs. only $250 with my approach!

Be careful with the advice you listen to when it comes to your credit. Clearly the bank had an ulterior motive with this type of advice. It sounds to me like it is a plan to generate higher deposits instead of the best and fastest way to generate a FICO score for this person!

How long will it stay?

One of the most common questions I get from people is regarding how long certain items will remain on a credit report. Many people have heard all kinds of crazy answers, especially when it comes to negative information. People are usually shocked to find out how long something can stay on their report or they have been told lies by collection companies trying to scare them into making a payment. Here is the real truth about accounts and credit reporting limitations.

Accounts Paid on Time –Accounts that have never been late can stay on your credit report indefinitely or can be removed ten years from the last time the account had activity. If the account is closed, this would be based upon the date it was closed. If the account still has activity, it will stay until there has been no activity for 7 years.

Bankruptcies – Chapter 7, 11 and non-discharged or dismissed chapter 13 bankruptcies are removed in ten years from the filing date. Chapter 13s are removed seven years from date discharged, but not to exceed 10 years.

Charge-offs – Charged off accounts are removed seven years from the date it was charged off.

Collections – There are two types of collections: the original account, which was turned over to collections and an account reported by a 3^rd party collection agency. Original accounts remain for seven years from the time they went 180 days delinquent prior to the default. Accounts reported by a collection agency remain for seven years from the same date. This means that the collection can remain on your report no longer than the original account that went into default. No where in that statement did I mention “from the date it was PAID” this is because paying a collection does not change how long it can be reported to your credit report.

Inquiries – Inquiries are placed on your credit report to indicate who has looked at your credit report. Inquiries that you initiate from an application (such as credit card, auto or mortgage loan) will remain on your credit report for 2 years. These type of inquires are commonly known as “hard inquires” and they can negatively affect your score. When you request your own credit report, that inquiry stays for 6 months and nobody other than you sees it. Inquiries that you didn’t initiate, such as pre-approved credit offers or companies monitoring your credit report, remain for 6 months and are not seen by other companies and do not impact your score.

Judgments – Judgments stay on the credit report seven years from the filing date.

Repossessions - Repossessions are removed seven years from the date your auto loan went into default.

Tax liens – Tax liens include federal, city, state and county liens. They remain seven years from the date they’re released. If they aren’t paid they can remain indefinitely.

Keep in mind all these times are the maximum things can stay, that doesn’t mean they can’t come off sooner. Also unfortunately not all companies always follow the rules, just one more reason to check your reports regularly for inaccurate reporting.

Finally the TRUTH about Mortgage Inquiries

Understanding how inquiries impact your FICO score is easily one of the most complicated aspects of the scoring system. This is easily on the “Top 5” list of the most misrepresented facts about FICO scores. In efforts to clear this up here are some truths about credit inquiries and how they relate to your FICO score. What you will read is 100% accurate.

1. Inquiries are all specifically coded by the credit bureaus to reflect the industry from which they came. This means whatever “type” of credit you apply for will likely be clearly indicated. This is important because the “Type” of inquiry plays a key role in how it is evaluated.

2. Mortgage, auto and student loan inquiries are treated differently from all other inquiry types. If you don’t already know, these are the type of loans that you can shop for the best interest rates and terms. Shopping for these loans most likely will result in your credit report being loaded up with multiple inquiries in a short amount of time.

3. FICO doesn’t want to penalize smart consumers for rate shopping. So, rather than assume each inquiry indicates a discreet and unique credit application, they have built logic in their credit scoring model that identifies when you’re shopping for one loan rather than many loans.

Here’s how these 3 rules work in a mortgage application example…

Mortgage related inquiries, which are very easy to identify because of #1 above, are ignored for the first 30 days they’re on your credit reports. If you were to apply for a mortgage on August 15^th it will take until September 15^th to become “visible” to the FICO score. This means you can apply with 50 different mortgage loan lenders during that 30 day window and all 50 of those inquires will be ignored for FICO scoring purposes. In other words these inquires will have absolutely NO impact to your FICO score.

When the mortgage inquiries age past 30 days they become fair game and will be seen by the FICO scoring system. The rule doesn’t end there however. Any of those inquiries that occur within the same 45-day period will be treated as 1 inquiry for scoring purposes. So in my crazy example of applying for a mortgage with 50 different lending companies all those will only be counted as 1 inquiry because they all would have happened within 45 days of each other.

Many years ago the 45-day period was only 14 days. For this reason, you still hear some people claim that you only have 14 days to shop for a mortgage, which was true about a decade ago but isn’t true any longer.

These rules apply not only to mortgages but also to auto loans and student loans. It does not however apply to credit cards, which means if you apply for 3 credit cards then the 3 inquiries will immediately be seen by the FICO score AND they’ll all be considered unique loan/credit applications.